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Ballooning global debt and currency carnage

The world has started embracing reality by trading in currencies other than the US dollar

The US dollar has been considered as reserve currency and used commonly across jurisdictions for trade and transactions. Central banks and financial institutions worldwide hold their reserves predominantly in US dollars. Ideally, the purpose of a reserve currency is to aim for a stronger currency in value compared to local currency and access this reserve currency at the eleventh hour if required.

While the US dollar may continue to be stronger compared to the home currency for a larger number of countries globally, the shine of US dollars is gradually fading. The greenback’s role as the world reserve currency hinges on trust, liquidity, and deep capital markets. Of late, there are looming concerns questioning this supremacy of the US dollar and the so-called dollar hegemony. One of the most pertinent reasons for this assertion is the rising US debt.

Global debt has reached a staggering amount of $315 trillion as of March 31, 2024. US sovereign debt reached another all-time high of $35 trillion as on July 29, 2024, a figure that is not imaginable for nations globally, but for the US. As one single nation, US debt is almost 11.11 per cent of global debt. The US added $16 trillion of debt in five years from $19 trillion in 2019.

Considering that the US Dollar is their home currency, it may not make a difference whether this debt is actually repaid or rolled over. Commonly posed as a question and a dilemma for every layman, sane business entrepreneur and economist – is this staggering level of debt sustainable?

Well, we will never be able to find an answer and our own analysis and interpretation will only stay with us while the US debt will continue to rise further and yet maintain their sovereign rating. The speed at which the US government has been borrowing is mind-boggling. Just from Monday July 29 to Thursday August 1, another $ 00 billion was drawn down. Annually, the US government pays more than $1 trillion as interest on this staggering debt. Former Treasury Secretaries Hank Paulson and Timothy Geithner have warned that US debt growth will ultimately destroy our prosperity unless dealt with immediately.

This ballooning debt is a matter of concern for countries that are betting on their US dollar reserves as their flight to safety. Countries globally are now realising that on any given day, changes in US policies may impact them and bring instability in their own economy. It’s no longer a secret that China has been selling US Treasuries to reduce its holding from a staggering level of $1.3 trillion in 2014 to a level below $ 775 billion in May this year. Part of the sale proceeds realised from sale of US Treasuries have been actively used by China to finance commodity purchases and boosting gold reserves. Many other countries have equally considered to raise their gold reserves, contrary to adding up US Treasuries. In contrast, Japan is by far the largest foreign owner of US Treasury securities, with Japanese banks, pension funds, insurance companies etc holding a total of $1.138 trillion at the end of 2023.

With higher debt and higher interest rates at the fore, the tale of rate cuts is becoming a tale within itself. The US Federal Reserve commonly quotes that it will pursue the rate cut decision meeting by meeting based on the statistics/data they receive. The Fed had paused interest rate changes after the last rate hike in May 2023, considering job numbers and inflation data and maintained the Fed Funds target rate at 5.25 per cent to 5.5 per cent. While the world is aware that two per cent inflation target pegged by Federal Reserve seems to be illusionary vis a vis actual inflation rate that is much higher, The US central bank has continued with its standard response of maintaining a pause without any rate cut in the recent meeting of July 31, 2024 and the financial markets do not seem to like this stiff and stern approach of Federal Reserve, given the optimism raised globally considering rate cuts by central banks of other developed and developing nations.

Global central banks are cutting rates at the fastest pace since Covid. So far, we have already witnessed 35 rate cuts till July 31 by central banks globally, as compared to 92 rate cuts in May 2020 (Covid era) and 76 rate cuts in April 2009 (global financial crisis). As always, the Federal Reserve seems to march ahead on their track of going wrong again by being late to initiate rate cuts as compared to other central banks globally.

The financial markets are now pricing in first rate cut of 25 to 50 basis points to be announced on the Fed’s statement scheduled on September 18. Markets are now projecting three cuts (75 basis points) in 2024, taking the Federal Funds rate down to 4.50 per cent-4.75 per cent by the end of this year. Markets expect a further four cuts in 2025, taking the rate down to 3.50 per cent-3.75 per cent by the end of next year. The most pertinent question is – will the Federal Reserve cut rates as the financial markets anticipate? The answer to this question may not be in affirmative or certain at this moment considering the staggering pile of debt US is currently holding.

To continue raising debt, US may need to ensure their interest rate is attractive for investors to invest. While you and me as individuals or corporates cannot expect commercial banks to finance such borrowing expectations, the US government is running substantial budget deficits and the US Treasury is borrowing heavily at its regular auctions of Treasury bills, notes, and bonds to finance this deficit. Nearly $1 trillion of additional net issuance in US Treasury bonds have taken place in the first six months of 2024 alone. The US economy has been undergoing contraction considering recent reading of ISM manufacturing index reading of 46.8 that was well below Dow Jones estimate of 48.9, both readings below 50, a clear sign of contraction. Analysts are flashing signs of a recession, much ahead of confession by Federal Reserve and the federal government.

Despite all odds, the height of dollarisation through US Treasuries or debt or financial markets has been in limelight always. The current US stock market cap stands at approximately $58 to $59 trillion while GDP for 2023 was $28.78 trillion and current US government debt stands at $35.1 trillion. These numbers are like three different points in a triangle, that will continue to stretch and create more and more imbalance economically for the world. Debt to GDP ratio currently stands at 122 percent and this has been rising continuously. World central banks and leaders have been taking cognizance of this massive quantitative easing (QE) followed by a slight quantitative tightening (QT) as merely an eyewash, considering US government debt that is just breaking through the roof every day.

The swings in US financial markets, off late, in terms of adding and reducing billions and trillions on a day basis is certainly concerning and unprecedented. The recent turmoil in the financial markets must not be taken lightly. It is clear this sailing is only going to get rougher while the central banks and the policy makers globally try and safeguard their homeland first, leaving the outside world in isolation. A classic case is Japan, ending 30 years of negative rate regime and raising interest rate to the extent of 0.25 per cent in the last three months, a move that has shaken the hedge funds. This unexpected move triggered widespread asset liquidation of trillions of dollars worth of trades, creating ripple effects across international markets and contributing to the current downturn. Hedge funds have been borrowing Japanese yen at zero interest and investing in markets overseas and the recent change in direction of zero interest to positive interest rate has given a massive jolt to this strategy opted by Hedge Funds who opted to unwind positions. Imagine Japanese yen rising from 127.21 yen to the dollar on January 16, 2023 to a high of 161.80 yen on July 11, 2024, a devaluation of 27 per cent in a span of 18 months and retracing to a low of 141.684 to the US dollar on August 5. Such moves in a span of three weeks is unprecedented. The rising yen has jolted the US dollar index, which dropped from a high of 106.13 on June 26 to a low of 102.47 on August 5, and the expectation is a further push downside. This carnage is not common and its consequences of such moves are not going to disappear so easily as the commercial traders battle to balance their moves ahead, including but not limited to reconfiguring their algorithms that trigger billions of dollars’ worth of trades daily and the capitulation taking place in the financial markets.

The world has started embracing reality by trading in a currency other than US dollar and some countries like China initiating international trade transactions in their own currency. Brics nations (Brazil, Russia, India, China and South Africa) are actively considering setting up a transaction network similar to SWIFT that may help create a new economic reality for their countries. To put things in perspective, the GDP of Brics nations combined exceeds GDP of the G7 nations. Hence, the voice of Brics nations cannot be ignored or undermined.

Is the US dollar hegemony showing signs of cracking? Its clear that the doors have opened for the world to consider alternatives as number one does not remain number one for ever. Earlier, the British pound used to be a reserve currency and the US dollar managed to clinch numero uno position back in 1971. On the other hand, the concept of digital currency is gaining more and more traction, outside the Federal Reserve (knowing that Federal Reserve is not keen or interested in pursuing an alternative).

Can we envisage a digital reserve currency that is common for the world and backed by gold or some form of tangible security, unlike the US Dollar that is just a trust statement written on paper? World leaders seem to ponder on this thought, but consensus may not come through in a short span of time. Someone must start somewhere, be it before the catastrophe or after. Till the time consensus prevails globally, we will continue to witness a multi polar world and self-interest or vested interest will always be considered supreme over unbiased global interest. US Dollar Hegemony is at stake while Countries try to choose every possible alternative, to the extent feasible and practicable.

At the current juncture, the interplay between geopolitics and economics is evident. Political decisions have far reaching consequences on economies at times, that may not be anticipated ahead of time. These developments globally add more and more uncertainty for the world economy and the damages are going to be heavy, if the situation gets uglier. Its time for sanity to prevail and world leaders endeavour to strike a balance instead of rocking the boat or pulling in the opposite direction.

Like I always caution, brace for impact ahead….

The writer is CEO of ZTI Global